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July 2014 Personal Income and Expenditures Under Expectations

It is not really the problem that this noisy data series disappointed this month, but it throws a monkey wrench into the gears of those who believe the economy will be building steam as the year progresses. Consumer spending growth was less than last month - and in a consumer economy, the opposite needs to happen for the economy to pick up steam.

Follow up:

The market looks at current values (not real inflation adjusted) and was expecting:.

Consensus Range

Consensus

Actual

Personal Income - M/M change

0.1 % to 0.5 %

0.3 %

0.2%

Consumer Spending - M/M change

0.0 % to 0.3 %

0.2 %

-0.1%

PCE Price Index -- M/M change

0.0 % to 0.2 %

0.1 %

0.1%

Core PCE price index - M/M change

0.1 % to 0.2 %

0.1 %

0.1%

In other words, both income and spending were below expectations.

The monthly fluctuations are confusing. Looking at the inflation adjusted 3 month trend rate of growth, income continues to trend down and expenditures continues to trend down.

Real Disposable Personal Income is up 2.6% year-over-year, and real personal expenditures is up 2.0% year-over-year (table 10).

this data is very noisy and as usual includes moderate backward revision (detailed below) making real time analysis problematic.

Yesterday, the second estimate of 2Q2014 GDP indicated the economy was growing at 4.2%. Expenditures are counted in GDP, and income is ignored as GDP measures the spending side of the economy. However, over periods of time – income and expenditure must grow at the same rate. Usually this differential signals a future slowdown of consumer spending growth.

The savings rate continues to be low historically, but improved this month.

The inflation adjusted income and consumption are “chained”, and headline GDP is inflation adjusted. This means the impact to GDP is best understood by looking at the chained numbers. Econintersect believes year-over-year trends are very revealing in understanding economic dynamics.

Per capita inflation adjusted expenditure has exceeded the pre-recession peak.

Seasonally and Inflation Adjusted Expenditure Per Capita

Per capita inflation adjusted income is above pre-recession levels.

Seasonally and Inflation Adjusted Income Per Capita

Backward revisions this month:

Estimates for personal income and DPI have been revised for January through June; estimates for PCE have been revised for April through June. Changes in personal income, in current-dollar and chained (2009) dollar DPI, and in current-dollar and chained (2009) dollar PCE for May and June -- revised and as published in last month's release -- are shown below. Estimates of wages and salaries were revised from January through June. The revision to first-quarter wages and salaries reflect the incorporation of the most recently available BLS tabulations of first-quarter wages and salaries from the quarterly census of employment and wages. Revised estimates for April, May, and June reflect extrapolation from the revised first-quarter level of wages. In addition, revisions to May and June reflect revised BLS employment, hours, and earnings data for those months.

The graph below illustrates the relationship between income (DPI) and expenditures (PCE) – showing clearly income and expenditures grow at nearly the same rate over time. In dollar terms, incomes are growing faster than consumer expenditures – and this is positive for long term economic growth.

The long term trend remains that the consumer is spending more of its income - although the growth rate has been in a tight range for over one year.

Seasonally Adjusted Spending’s Ratio to Income (a declining ratio means consumer is spending less of its Income)

PCE is the spending of consumers. In the USA, the consumer is the economy. Likewise, personal income is the money consumers earn to spend. Even though most analysts concentrate on personal expenditures because GDP is based on spending, increases in personal income allow consumers the option to spend more.

There is a general correlation of PCE to GDP (PCE is a component of GDP). PCE is not very noisy compared to GDP, but subject at times to significant backward revision (see caveats below).

The savings rate has been bouncing around – but the general trend is down. In an economy driven by consumers, a higher savings rate does not bode well for increased GDP. This is one reason GDP may not be a good single metric of economic activity. The question remains what is the optimal savings rate for the current demographics. It might be expected that as people near retirement, the savings rate rises and after people retire, savings rate falls. Econintersect is not aware of any study which documents this effect. The graph below is from BEA table 2.6. – and shows a significant fall in savings rate for January 2013 – and now remains range bound. The savings rate is now 5.7% – last month was 5.3%.

Personal Savings as a Percentage of Disposable Personal Income

And one look at the different price changes seen by the BEA in this PCE release versus the BEA’s GDP and BLS’s Consumer Price Index (CPI). We should note that the inflation adjustment is for PCE and Personal Income is lower than the ones used for GDP and CPI.

Finally for recession watchers, here is the graph below, here are the elements used to mark a recession. (1) personal income less transfer payments, in real terms and (2) employment. In addition, we refer to two indicators with coverage primarily of manufacturing and goods: (3) industrial production and (4) the volume of sales of the manufacturing and wholesale-retail sectors adjusted for price changes.

If a line falls below the 0 (black line) – that sector is contracting from the previous month. Personal income is the blue line. Note – the below graph uses multipliers to make movements more obvious (ignore the value of the scale, only consider whether the graph is above [good] or below [bad] the zero line).

Caveats on the Use of Personal Income and Consumption Expenditure Data

PCE is a fairly noisy index and subject at times to significant backward revision. This index cannot be relied upon in real time.

This personal income and personal consumption expenditure data by itself is not a good tool to warn of an upcoming recession. Econintersecthas shown that PCE is a distraction for recession watchers, with moves over a few months having a 30% accuracy of indicating a recession start, and a 70% incidence of indicating a non-recessionary event. The graph below shows the lack of correlation. Note, however, that PCE does have prolonged declines over many months associated with recessions but these long declines are not very good in “predicting” a recession until it is already underway.

Readers are warned that this article is based on seasonally adjusted data. Monthly non-adjusted data is available with a delay of several months.

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